The coal-mining industry has been hard hit by low natural gas prices and a broad shift away from "dirty" fuels. It hasn't been pretty, with industry giants like Peabody Energy (NYSE:BTU) forced into bankruptcy and Cloud Peak Energy (NYSE:CLD) cutting production levels by 35% between 2010 and 2016. But Alliance Resource Partners, L.P. (NASDAQ:ARLP) has stood out from the pack, despite a distribution cut. And while the outlook for coal isn't great, Alliance looks like it will keep rewarding investors with hefty distributions for years to come.
Coal isn't dead yet
Let's get two things out of the way up front. First, the U.S. thermal coal industry will never be what it once was. Too many coal plants have been shut and replaced with natural gas power stations for coal to return to its former glory. However, coal isn't dead. It still accounts for roughly a third of the electricity used in the United States. And according to the U.S. Energy Information Administration (EIA), coal is going to be around for decades into the future despite the changes taking place around clean energy.
But if coal isn't going to return to what it once was, then how exactly do we find the best player in the space? In the case of coal, the answer is outperformance through a slow and drawn-out industry decline. But here's the key for Alliance: It's going to pay unitholders handsomely along the way. The partnership currently offers a hefty 8% distribution yield that it covered by a massive two times in 2016. For reference, coverage of 1.2 times is considered good for a limited partnership. After the first quarter, Alliance hinted that distribution hikes might be in the cards in the near future.
The past and the future
There are two reasons to believe that Alliance will continue to thrive even in a difficult market for coal. The first is the company's past. Coal has been deeply depressed, with some companies forced to significantly cut production (Cloud Peak Energy) and many industry players forced into bankruptcy court (Peabody, Arch Coal, Alpha Natural Resources). Blood was flowing on the bottom line at most coal companies -- but not Alliance. Despite the downturn, Alliance Resource Partners remained profitable throughout. It's basically proven it can handle horrible industry conditions in stride.
A key reason for this is that Alliance's business is centered around the Illinois Coal Basin, a region that has been gaining market share as other regions have faltered. To put some numbers on that, Alliance's coal production fell last year but it was still up nearly 20% from the levels achieved in 2010. Compare that to the 35% production decline at Cloud Peak Energy, which focuses on the Powder River basin.
The location has clearly mattered a lot. And, according to the EIA, it's going to remain an important factor in the future. The interior region, which included the Illinois basin, is projected to increase its share of the coal market from 20% in 2016 to 26% in 2040. That puts Alliance in the sweet spot of the coal industry. That doesn't necessarily mean growth, however, since other coal regions are likely to shrink. But it does suggest that Alliance can maintain industry-leading results for years to come.
The big win
Even through the worst of the coal downturn Alliance was able to do pretty well. The region it operates in is expected to hold up better than others as coal continues its slow decline. And Alliance covered its distribution by roughly two times last year (even more than that in the first quarter), hinting that it might start to increase the distribution again in the near future. And while it cut the distribution in 2016, its massive distribution coverage ratio proves that the move was largely related to assuaging worried capital markets.
All of this means you can buy Alliance today and collect a solid 8% yield with confidence that the coal miner will continue to reward you with distributions well into the future. Don't expect massive growth at Alliance; look for industry-leading results supporting a hefty yield -- and maybe even some modest distribution hikes along the way. If you're an income investor, that future should sound pretty good.
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